Secured vs. Unsecured Debt: How Lenders See Them

Written by Posted On Thursday, 30 September 2021 00:00

A mortgage is a type of loan to finance real estate. The real estate can be a residential property or it can be a commercial one. The terms mortgage and loan aren’t necessarily interchangeable. Yes, a mortgage is a loan but a loan isn’t necessarily a mortgage. One of the primary differences is whether or not the loan is deemed ‘secured.’ What does the term secured mean? It means the lender has placed a lien on the item being financed. This collateral reduces the amount of risk to the lender. Should the borrower ever default, the lender issuing the secured note and recover the asset via repossession or foreclosure. Someone for example with an automobile loan who goes a few months without making a payment might soon discover their car is no longer in the driveway…the lender took it back. Further, if the current value of the asset isn’t enough to pay off the existing loan balance, the borrower is still on the hook for the remainder.

This leads us to the terms secured and unsecured debt. An automobile loan is an easy way to understand security. If payments are made on time each month, or at least during that month, the automobile stays in the driveway. That said, most notes have language that allows the lender to charge a late fee if the payment is not received by a certain date. A note might have a payment due date on the 1st of the month but if the payment is not made by the 15th, a late penalty fee will be tacked on. 

And because the automobile loan is secured, if the payments are not made, the lender will take back the car. When the automobile loan is ultimately paid off, the lender will release the lien on the car and shortly thereafter a release of lien notice will be sent to the owners, showing that the lien no longer exists and the automobile is ‘free and clear’ of any monthly obligations.

Mortgages are also a secured debt. In the same manner, the lender has a legal interest in the property while the mortgage is still in place. Each month as a mortgage payment is made a portion of the payment goes toward the lender for interest due and a portion goes directly to the outstanding loan balance. A mortgage is indeed a loan, but an automobile loan is not a mortgage. The terms are not interchangeable.

An unsecured loan is one where there is no collateral attached to the note. A common unsecured loan can be debt acquired with a credit card. Someone with a credit card can go out and buy a new suit and make monthly payments on the card. Using this example, if someone can longer make the payments on the card and can’t make any financial arrangements with the card issuer, the issuer can send the outstanding balance to a collection department or agency and ultimately charge off the balance altogether. With unsecured debt, the lender won’t try and recover the business suit. There is no lien attached. This process works with any type of unsecured debt.

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David Reed

David Reed (Austin, TX) is the author of Mortgages 101, Mortgage Confidential, Your Successful Career as a Mortgage Broker , The Real Estate Investor's Guide to Financing, Your Guide to VA Loans and Decoding the New Mortgage Market. As a Senior Loan Officer and Mortgage Executive he closed more than 2,000 mortgage loans over the course of more than 20 years in commercial and residential mortgage lending. 

He has appeared on CNN, CNBC, Fox Business, Fox and Friends and the Today In New York show. His advice has appeared in the New York Times, Parade Magazine, Washington Post and Kiplinger's as well as in newspapers and magazines throughout the country. 

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